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  • Stock Recommendation | Hero Motocorp - SELL - Target price : 2,600

    Publish date: OCTOBER 17, 2018

    Results below estimates. Hero MotoCorp reported 5% yoy decline in EBITDA in 2QFY19 largely led by decline in gross margin on a yoy basis due to input cost pressures. The company’s loss of market share in the scooter segment and slowdown in industry growth led by rise in insurance cost is a key concern, in our view. Maintain SELL rating with an unchanged target price of ₹2,600.

    Hero reported 2QFY19 net profit of ₹9.8 bn (down 3.4% yoy), which was in line with our estimates as 3% miss at the EBITDA level was offset by higher other income. Revenues increased by 8.7% yoy led by (1) 5.5% yoy volume growth and (2) 3.1% yoy increase in net realizations. EBITDA for the company declined by 5.3% yoy in 2QFY19 due to 220 bps yoy deterioration in EBITDA margin. EBITDA margin was 15.2% in 2QFY19 (KIE: 15.8%) versus 17.4% in 1QFY18. Gross margin declined by 120 bps yoy (+70 bps qoq) due to (1) increase in commodity costs and (2) expiry of Haridwar incentives. Staff costs and other expenses increased by 13-19% yoy leading to negative operating leverage. Other income was higher at ₹2.2 bn, +90% yoy due to interest income related to income tax deposits, which came this quarter. Tax rate increased to 32.6% due to expiry of tax incentives in the Haridwar plant. The company indicated tax rate would remain at 31-32%.
    The company indicated that initial few days of the festive season has been muted (flattish growth) but expects demand to pick up over the next few days. The company expects 8-10% yoy growth in the domestic two-wheeler industry in FY2019 as compared to double-digit growth guidance given earlier. Rural growth is marginally outpacing urban growth for the company currently.

    We expect Hero’s domestic volumes to grow at 5% CAGR over FY2018-21E, in line with our industry growth estimates. We expect the domestic two-wheeler industry growth to slow down due to increase in costs related to rise in insurance cost and regulatory costs such as ABS/CBS, BS-6 related costs. We expect Hero to maintain share in the economy and executive bike segments. We expect EBITDA margin to decline from FY2018 levels (~16.4%) over the next two years led by increase in competitive intensity in the sector. We thus expect Hero MotoCorp to deliver only 2% EPS CAGR over FY2018-21E.

    We retain our earnings estimates and target price. Our target price of ₹2,600, is based on 13X September 2020E core EPS + ₹440 cash/share (including investments).

    ▶ Dealer inventory levels are around 4-6 weeks. The company expects 8-10% yoy growth in the domestic two-wheeler industry in FY2019 and indicated that first few days of the festive season have seen a flattish growth. The company believes it can increase market share in scooters with the launch of two 125cc scooters (one model will be launched nationwide over the next three weeks and the next model in 4QFY19) and premium motorcycle segment in FY2019 led by new model launches.
    ▶ The company believes 125cc scooter segment is growing at a significantly higher pace than 110cc segment, hence with products available in 125cc segment should improve the company’s market share in the scooter segment. 125cc scooter segment is now 21% of domestic scooter industry volumes versus 15-16% in FY2018. The company indicated 110cc scooter segment is not growing; hence their market share is getting impacted. We believe that it will be difficult for the company to maintain overall two-wheeler market share due to weaker presence in high-growth segments such as scooters and premium motorcycle segment. We expect Hero MotoCorp’s domestic volumes to grow at 5% CAGR over FY2018-21E.
    ▶ The company has presence in 35 overseas markets; the company has recently entered Argentina and Nigeria markets, which will aid growth going ahead. The company expects decent growth from markets such as Sri Lanka, Bangladesh and Nepal while markets such as Colombia are facing headwinds due to a weaker economic scenario. In Bangladesh, the company has achieved 30% market share in a short time-frame and has gained No. 1 position in the past two months. The company expects double-digit growth in export market in FY2019.
    ▶ Spare revenues for the company grew by 24% yoy to ₹7.1 bn in 2QFY19. ▶ The company has guided towards A&P spend at 2.5-3% of sales on full-year basis as compared to earlier guidance of 2.5% of sales. The company, however, reiterated its overall EBITDA margin guidance at 14-16%.
    ▶ Haridwar plant (currently enjoying excise duty benefits) accounted for 34% of the company’s total production in FY2018. The company has realized only 58% of the Haridwar benefit in FY2018, which was part of the central government while 42% compensation has to be borne by the state government. Excise incentives at Haridwar plant used to add 140 bps to the company’s EBITDA margin, which got reduced to only 60-70 bps in FY2018. This incentive was not available to the company from 1QFY19, which impacted gross margin of the company in 1HFY19. In FY2019, 60 bps negative impact on EBITDA margin due to expiry of incentives in Haridwar plant will be partly offset by higher incentives due to increase in production from Rajasthan and Halol plants.
    ▶ Gujarat production was 300,000 units in FY2018, which will increase to 600,000 units in FY2019 and 900,000 units in FY2020. In FY2018, ₹5.5 bn (10.5% of EBITDA) was added to revenue due to incentives received by the company from the government for production done at Haridwar, Rajasthan and Gujarat plants. In FY2019, approximately ₹2.8 bn incentive has expired due to expiry of incentives at Haridwar plant. However, with increase in production at Gujarat and Rajasthan plants, the company can offset part of the benefits lost in Haridwar plant. Sales volumes for Hero in Gujarat and Rajasthan were around 1.1 mn units in FY2018.
    ▶ CBS/ABS has become mandatory from April 1, 2018 for new models and will be mandatory from April 1, 2019 for old models, which could lead to significant increase in costs for the company. The company also gets incentives in Rajasthan and Halol plants, which have started production. The company is guiding for overall capex of ₹25 bn over the next two years towards product development, capacity expansion in Gujarat and new plants in Andhra Pradesh and Bangladesh. The company indicated cost of CBS would be ₹500/bike while for ABS it would be ₹4,000/bike.
    ▶ Hero FinCorp financed 11% of Hero sales in 2QFY19 and 13% of Hero sales in 1QFY19 (11.5% in FY2018). ~35% of Hero’s vehicles were financed in FY2018, which has increased to 36.5% in 2QFY19. The company indicated that the two-wheeler sector is not facing any financing constraint in light of liquidity issues of NBFCs.
    ▶ The company also gave out estimates of scooter mix in urban-rural market and similar figures for motorcycles. Scooter mix in urban and rural markets is 75%:25% and motorcycle mix is 50%:50% in domestic two-wheeler industry in India, as per the company.
    ▶ The company made an investment of ₹1.3 bn in Ather Energy through compulsorily convertible debentures in 1QFY19. Further, the company has also participated in rights issue of Hero FinCorp and invested ₹2.5 bn in 2QFY19 (total investment in hero FinCorp so far is ₹7.8 bn) to maintain its existing stake (41.03%) in the entity.
    ▶ Receivable days for the company increased to 28 days of sales in September 2018 as compared to 16 days of sales in FY2018. As per the management, this is due to higher credit period offered to dealers to maintain high inventory ahead of the festival season. Payables also increased to 44 days of sales in September 2018 from 35 days of sales in FY2018. Overall cash conversion cycle still remained negative at 6 days of sales in September 2018 (negative 10 days of sales in FY2018).

    Definitions of ratings

    BUY - We expect this stock to deliver more than 15% returns over the next 12 months.
    ADD - We expect this stock to deliver 5-15% returns over the next 12 months.
    REDUCE - We expect this stock to deliver -5-+5% returns over the next 12 months.
    SELL - We expect this stock to deliver

    Our target prices are also on a 12-month horizon basis.

    Other definitions

    Coverage view. The coverage view represents each analyst's overall fundamental outlook on the Sector. The coverage view will consist of one of the following designations: Attractive, Neutral, Cautious.

    Other ratings/identifiers

    NR = Not Rated. The investment rating and target price, if any, have been suspended temporarily. Such suspension is in compliance with applicable regulation(s) and/or Kotak Securities policies in circumstances when Kotak Securities or its affiliates is acting in an advisory capacity in a merger or strategic transaction involving this company and in certain other circumstances.
    CS = Coverage Suspended. Kotak Securities has suspended coverage of this company.
    NC = Not Covered. Kotak Securities does not cover this company.
    RS = Rating Suspended. Kotak Securities Research has suspended the investment rating and price target, if any, for this stock, because there is not a sufficient fundamental basis for determining an investment rating or target. The previous investment rating and price target, if any, are no longer in effect for this stock and should not be relied upon.
    NA = Not Available or Not Applicable. The information is not available for display or is not applicable.
    NM = Not Meaningful. The information is not meaningful and is therefore excluded.

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